Home Buying Guide
Buying a home is one of the most exciting undertakings in life, and can be one of the most stressful and confusing. This simple and concise guide is designed to point out the most confusing parts of house-hunting, and to hopefully shed some light on some of the details of the process for those who are buying a home for the first time.
Searching through available houses is easier than ever, with sites like Redfin and Zillow, it only take a few clicks to find a full list of properties available for sale in your desired city or neighborhood. So finding properties is not the difficult part, but plucking out the one that speaks to you out of the hundreds of listings can be tough. Keep in mind that this getting frustrated with the home selection part of this entire undertaking does not have to be rushed. It is important to feel mostly comfortable with the property--no property is perfect, so you will never be completely happy, but at the same time compromising too much may be reason for regret in the future. Try not to get emotionally attached to a certain property or it may cloud your judgment when it comes time to negotiate.
Affordability - Can I Afford to Buy?
So you have started thinking about buying a home, and now it is time to figure out how much house can you comfortably afford. The important thing to keep in mind here is to make certain that you are not stretching your income, and creating undue mental and emotional stress, and also potentially putting your financial future in jeopardy.
It is not a complicated calculation to figure out how much house you can afford, but be sure to be honest with yourself and come up with a realistic number. The below formula is what the banks will use as part of qualifying you for a loan, and you should use the same approach to figure out how much you can afford to pay for a house in monthly mortgage payments.
You will need the following information in order to make the calculations:
- Gross monthly income: this is the amount of money you make before taxes
- Monthly debt payments: This total should include payments such as credit cards, student loans, car payments, and any other long-term monthly payments for which you are responsible. For example, if you help out a relative or friend with a $200 per month allowance, and you will have this expense for the foreseeable future, then it is a good idea to include that in your monthly debt considerations (this is not something the bank will ask for, but you should consider it for your own personal calculations).
- Term of mortgage loan: The most common loan term is 30 years.
- Mortgage rate: Figure out what the current mortgage rates are (don't rely on the lowest rates published by online sources).
- Property tax rate: Find out what the property tax rate is in the area which you would like to purchase a home.
- Homeowner's Insurance: Find out how much home insurance will cost.
- Down payment: How much are you able to contribute towards a down payment?
Once you have these two numbers, then you can calculate the home you can comfortably afford. Basically, your debt payments should be no more than around 35% of your gross income. Let us assume the following is true:
- Monthly Gross Income: $6,000
- Monthly Debt Payments: $1,000
- Loan Terms: 30 years
- Mortgage Rate: 5%
- Property Tax Rate: 1%
- Homeowner's Insurance: $700 per year
- Down Payment: $20,000
We'll start by figuring out what your income to debt ratio is: 1000*100/6000 = ~16%
This means that you have room to increase your monthly debt by 20%. This would mean that you can afford a monthly payment of $1,200. But this is the roughest calculation you can make, so let's delve a bit deeper. This means that you would need to keep your monthly payment, including property tax and insurance at or around $1,200 per month, after placing a $20,000 down payment. If your down payment is smaller or larger than $20,000, this would of course impact how much house you can afford.
So when you are looking at properties on Redfin, or Zillow, do keep an eye on the monthly payment. Or just use our Affordability Calculator.
Qualifications - Down Payment & Loan Approval
Before you go looking for a lender, and figure out if you qualify for a mortgage loan, there are some basic thing of which you should have a fair grasp.
It is highly recommended, that a home buyer have at least a 20% down payment to place on the property they are looking to purchase. Lenders like to see at least that percentage of the property price covered; however, you can still get a loan with a smaller down, but you will have to accept less favorable loan terms (e.g., higher interest rates). The reason that banks like to see a 20% down is to bring down the Loan to Value (LTV) ratio. The loan to value ratio is obtained by dividing the loan amount by the appraised value of a property. For example, if you are purchasing a $100,000 property with a 20% down, and the house is appraised at $100,000, then you would have an LTV of 80%. The lower the LTV, the more comfortable the lender will be with giving you the loan, this is why it is important to negotiate the lowest price you can for the home, and hope that the appraisal will come in at above the agreed upon price.
Debt to Income Ratio
There are two types of debt ratios that lenders consider: 'front-end ratio', and 'back-end-ratio'. The front-end ratio is the housing costs (i.e., mortgage payment, tax, insurance, HOA fees, etc) divided by your gross monthly income. The back-end ratio is your monthly debt payments (e.g., student loans, car payments, etc) and your housing costs divided by your gross monthly income. In general, the front-end ratio should be at or below 28%, and the back-end ratio should be at or below 36%.
If you have a credit of over 720 (or thereabouts) then you are in a fairly good spot, and should not have to worry about your credit score causing a roadblock on the way to getting a mortgage loan. So figure out what your credit score is, to get an idea of where you stand.
Picking a Lender
As with any customer experience, perspective home buyers should evaluate their lender based on responsiveness, courteousness, and their willingness to spend time with you and explain the details of the loan and keep you apprised of what is happening with your loan application. Do not be afraid to switch lenders if you do not feel comfortable at any point. You will be taking on a huge amount of debt, and it is important to feel completely at ease with the process.
Finding a Home
Nowadays it is extremely easy to look for available properties through the use of websites such as Redfin, and Zillow. These, and similar, websites provide a host of search tools with an array of filters to find all the properties that match your criteria. Do keep in mind that some of the data available through such services may be delayed by up to a few days--if you want the most recent data you can use realtor.com (or go through your broker), but the site itself is not as user-friendly as other providers.
When you are trying to decide on a home, figure out a list of things that are important to you. Do keep in mind that you will most likely not get everything you want on that list, but the goal should be to come as close as possible, so that there are no regrets later down the line.
Negotiation Tips & Strategies
Negotiations and strategic planning is generally the job of the real estate broker; however, it is important to become familiar with the process so that you can either properly contribute, or to take a bigger role and simply utilize the broker for support. To do so, you must do extensive research, not only on the properties under consideration, but also the neighborhood, and the property market. It is also helpful to know as much about the sellers as possible. This information may give you an advantage during negotiations. Depending on the market, you may need to be aggressive in your demands, or try to come as close as you can to the sellers requirements.
In a Buyer's Market
If you find yourself looking to purchase a property in a buyer's market, then you will have a more dominant position than if you were to attempt a purchase in a seller's market, so keep this in mind, and try to extract all the advantages that come with being in a commanding position.
- Figure out the maximum price you are willing to pay for the property, and make an offer that is 10 % to 15% lower than that price, which will leave you room to negotiate if the seller is not happy with the offer. Don't be shy about this, and if your agent disagrees, then don't hesitate switching agents--there are tens of thousands of dollars at stake, and you cannot waste time with a timid agent.
- Ask for the seller to pay most or all of the closing costs, and include contingencies and a closing date that is most convenient for you.
- If you are looking to get at least some of the appliances or other items as part of the deal, then you may have a fair chance of getting them as part of the deal or at a huge discount, so don't hesitate to ask for them to be included in the deal.
In a Seller's Market
If you are scrambling to find a house in a seller's market, then you cannot be as demanding as you could in a buyer's market. In fact, you might not be able to demand anything other than the basic contingencies.
- Offer the full asking price, or even go a bit over, to show you are serious.
- Make sure that you have a pre-approval for the loan that you can submit with your offer so that the seller knows she can rely on your ability to go through with the purchase.
- Ask for only the most standard contingencies (i.e., approval of financing, appraisal of the property, and the home inspection).
In Lukewarm Market
In a market where neither the buyer nor the seller are at a disadvantage, the process is less contentious--each side knows that they have to give up something. With this in mind, make your offer balanced by asking for some things that are favorable to you, but also include terms and conditions that make the seller feel good about the potential deal.
Contingencies are terms in the offer (which eventually end up in the purchase contract) which are designed to protect the buyer dragon the escrow and purchase process. Contingencies that are likely to consider when making an offer are as follows.
- Appraisal: The appraisal contingency states that if the lender appraisal of the property comes in lower than the agreed-upon purchase price of the subject property that the buyer has the right to back out of the purchase.
- Loan: The loan contingency states that if the buyer is not able to obtain a loan that she can back out of the deal.
- Home Inspection: The home inspection contingency states that if the inspection reveals major and costly repairs for which the seller is not willing to pay, then the buyer has the right to back out of the deal.
- Lead-based Paint & Wood Destroying Agents: If the inspection finds that there are termites present or the house has lead-based paint, and the seller is not willing to cover the cost of mitigation, then the buyer has the right to back out of the deal.
Other contingencies could include things such as ones by the seller which might require that the buyer allow the seller to rent the property for a few months at an agreed upon monthly rent so that the seller has time to purchase a new house.
Your broker will help you design the necessary contingencies to protect your interests, but do keep an eye out for potential issues which might need to be addressed with contingencies.
Home inspections are possibly the most important part of buying a home--it allows the buyer to find out whether there are any issues with the property which may need to be addressed before the purchase goes through.
Home inspectors either work alone or as part of a company offering inspection services. It is best if the buyer finds an independent home inspector and not necessarily use one recommended by either of the brokers or the seller. The process of inspecting the home can and should be very thorough, as it determines whether the property is in good condition. The most important parts of the inspection are the checking for...
- Roof damage
- Signs of termites
- Sign of flooding or water leakage
- Cracks in the walls, foundation, or masonry
- Air conditioning system in proper working condition
There are of course many other details which will be on the home inspector's checklist, but if any kind of problem exists with the above list, the repairs could be very costly.
The Home Purchase Offer
Making a purchase offer on a property can be intimidating, especially if you are a first time homebuyer. It is important not to rely completely on your broker when making the offer, even though she will be submitting the paperwork to the seller's agent, she may not provide all the details that may get your offer accepted. So, to take matters into your own hands, it is always helpful to include a letter to the seller from you explaining your reasoning behind the offer. The reason for this approach is that your broker may not convey in detail why your offer is what it is, and even if she does, the seller's agent may not pass on that information to the seller, but they both are required by law to submit any written document to the seller as part of the offer. It is sometimes possible to make an appeal to the emotions of the seller, for example, if the property is being sold by an older couple and you are purchasing your first home as new parents to be, an appeal to the seller's may get them to consider working with your offer, even if it is a little on the low end.
Your broker/agent will work on recommending a reasonable offer based on a variety of factors the most important of which will be the comparative sales in the same general neighborhood as the property in question.
Escrow & Closing Costs
The escrow process on its face is simple, but can be confusing to home buyers. The escrow (company) holds the down-payment and the money to be paid by the lender (to the buyer) into an escrow account, where it stays until the property has been transferred to the buyer, at which point the escrow releases the funds to the seller. Let us review this process in a bit more detail.
The escrow company is an impartial third party that holds on to your money until the buyer is in possession of the property (i.e., deed is recorded with the county). The escrow company also holds important documents during this process. The escrow company of course charges a fee, which is covered by the closing costs which was previously negotiated.
In certain instances money can be held back from the seller to cover costs. For example, if the seller promised to make repairs, but during the time of your final walk-through of the property it becomes apparent that the repairs were not completed, the money needed to make the repairs is 'held back' in escrow.
Once all of the details are taking care of, the seller has the money, and the buyer has are recorded deed with the county, the escrow is considered closed.